Each quarter, as we roll into January, April, July and October, we see a nice bump in the S&P 500 earnings estimate and this week was no exception: the good news is that the “forward 4-quarter earnings estimate” for the S&P 500 is now at a record at $112.26, surpassing the July 13th peak of $111.88, and a new record high for the S&P 500 earnings estimate (per ThomsonReuters).
The key word in that opening sentence is “estimate” – since this is a forward-looking guess, my own opinion is that it continues to get discounted as not achievable, even though corporate managements are loathe to be aggressive with guidance, analyst’s bottom-up work also has tended to be conservative over the last year, since analysts have been as cautious as management (that is just my impression), and the quality of corporate earnings – again, in my opinion – seems to be excellent.
How do we determine the “quality” of earnings ? We look at “operating cash-flow per share” or OCF/PS, and for just about everyone of the companies in our universe, the cash-flow per share is greater than the earnings per share, so while the forward estimate for the S&P 500 is 13(x) the forward earnings, the forward OCFPS is probably closer to 10(x) for the key benchmark. ( I hate to be that “loose” with a rigorous valuation statement like that, so let’s follow with an example.)
Today Intel is trading at 6(x) cash flow (defined as Intel’s market cap divided by 4-quarter trailing cash from operations). As of June 30, using Intel’s 10-Q, INTC’s 4-quarter trailing earnings per share was $2.46. Intel’s 4-quarter trailing operating cash-flow per share as of June 30, was $3.50.
So using Friday’s Intel close of $22.68, Intel is trading at 9(x) 4-quarter trailing earnings per share, and 6.5(x) 4-quarter trailing operating cash-flow per share (OCFPS).
This was just one example, and it is probably more of an extreme example, given the capital intensive nature of Intel’s business. I wouldnt expect to find this same disparity with a software company, for example, which is a much less capital intensive business, and for whom “capex” is usually deducted in the form of R&D. However, this is why we are still over weight Industrials: you get the same dynamic. The valuations for a lot of our industrials look much better on a cash-flow basis, than an earnings per share basis.
Why is this ? Well for starters, companies with a large amount of depreciation and amortization, which are non-cash-expenses, don’t impact cash-flow. In fact, in the operating cash-flow calculation, depreciation and amortization are added back into net income.
This is a topic warranting a separate article, as is the reason companies do not directly report “operating cash-flow per share”, so we will leave it for next week or when earnings slow down, and we can cover the topic intelligently for readers.
We continue to think that the 3rd quarter, 2012 earnings results will be the bottom or nadir of this cycle for the S&P 500. Expectations are very low coming into 3rd quarter numbers as – overall, for the S&P 50o in total – earnings are expected to decline -2.4% and revenues are expected to be flat year-over-year.
Given the pattern of how the numbers have evolved since the ’09 recession, my guess is actual q3 ’12 S&P 500 earnings will be end being +4% – 5%, and revenues will be slightly positive, as currency or forex impact, will be a positive in the 3rd quarter after being a drag in the 2nd quarter. For reasons cited above, managements have been vary cautious (no reason to be otherwise), analyst estimates have tended to be conservative (again, the “macro” has brought expectations down to a subdued level), and there have been few reasons for anyone involved with business to be aggressive.
Here is the expectations for q3 and q4 ’12 earnings growth by sector for the S&P 500. Q3 earnings growth is in the first column.
Cons discr: +7.7% and +16.8%
Cons stpl: 0% and 5.9%
Energy: -19% and -1%
Fincls: +4.9% and 29%
Hlthcare: -2.7% and +2.6% (large-cap pharma continues to trade well. More multi-year highs this week.)
Indust: +2.3% and +2.6%
Materls: -24% and +20% (rather big swing between q3 and q4 ’12. Those numbers were checked.)
Tech: +2.3% and +9%
Telco: -12.8% and +4.7% (another big swing between q3 and q4. )
Ute’s: -7.7% and -4%
S&P 500: -2.4% and +9.5%
We’ll be back tomorrow with a trading/market/stock update, and talk about some other things. This market rally since late July has caught a lot of investors off guard. We remain overweight technology, financials and industrials, within client accounts primarily due to valuation. Sentiment is poor, technicals are reasonable (although the stock market remains overbought) and fundamentals remain very attractive, for the large-cap universe. That is a good combination – we hope it continues. More tomorrow.
Alcoa reports earnings on Tuesday, October 9th, leading off the q3 ’12 earnings season, then Costco on Wednesday, and JP Morgan and Wells Fargo on Friday of next week.
Thanks for stopping by:
Trinity Asset Management, Inc. by:
Brian Gilmartin, CFA